Markets have had a wild ride so far this year. In my last letter after the new year, I mentioned markets would have a spike in volatility. We have seen this increase in volatility coinciding with two sharp drawdowns in just the first three months of the year with subsequent recoveries. After remaining below 14 on the VIX (Volatility Index) for most of 2017, the VIX spiked to 50 in February and maintained an elevated level over 16 so far for most of 2018. Currently, the VIX is at 21. I believe the most probable scenario at the moment is for the VIX to decline over the next few months until we hit late summer, early fall.

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I also predicted the rise in interest rates, where the yield on the 10-year treasury bond moved from 2.475% to 2.95%. The rise in the 10-year treasury bond contributed to the pullbacks this year in high-yield fixed-income and equity markets, as well as interest-rate sensitive investments. The 10-year US Treasury Yield is at the highest level in the past four years, which is tightening lending in the capital markets and putting pressure on companies that have over-leveraged their floating-rate debt capacity.

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The Fed Funds rate was also set higher at the FOMC meeting in March to 1.5% – 1.75%. Jerome Powell, the Fed’s new chairman, states an additional 3 more hikes this year and another 4 hikes next year. This aggressive monetary policy is primarily a consequence of a tight labor market, rising wages and the risk of uncontrolled wage inflation. Historically, the Fed has a terrible track record of actually hiking rates per their dot plot schedule. However, combating the economic boosts from the fiscal and monetary stimulus since the Great Recession, Powell may actually keep his word this time, depending on the level of inflationary impact from wage growth.

Finally, I predicted commodities would continue to rise, which occurred for crude oil. Gold and other commodities are still in a sideways pattern, but I do believe this will break to the upside by the end of the year. (See gold and silver is “Featured Charts” below) Should this prediction unfold, the rise in commodities may be the beginning of a newly established and longer-term upward trend for this asset class. Coincidentally, this would also correspond well with our current stage in our economic cycle, where historically inflation-sensitive assets, such as commodities, tend to increase in the latter stages of the economic cycle. I believe we are at or just beyond 3/5ths into our current economic cycle.

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Another correct prediction mentioned in my last letter is that emerging markets will outperform US equities. As you can see in the chart below, Latin America increased by over 17% and the Emerging Market index increased 6% since the end of last year, while the US markets are flat over the same time period.

Despite the Fed’s promise an aggressive schedule of hikes, monetary and fiscal policy will likely remain accommodative enough in the US, and especially in the developed international economies, to keep markets moving in an overall upward trend over the next few months. In addition, earnings continue to surprise on the upside, which has been helping maintain high valuations. These factors should be able to keep risk assets from falling off a cliff for the time being. However, GDP continues to be modest on average, pacing just over 2% over the last several years. Yet, GDP could finally start to get a boost Q2, Q3 and Q4 of 2018. Nonetheless, markets are still vulnerable to many growth-related, geopolitical and other exogenous factors that could derail the market. As we sit now, the market is still struggling to re-establish its longer-term upward trend and continue higher. However, thus far, the long-term upward trend is still intact and it is unlikely that a sharp and significant pull-back will occur in the near future. However, it is always possible that we could experience a massive drawdown come the fall period, which historically has been the worst season for markets, including 1929, 1987 and 2008’s massive declines. We will have to keep a close eye as we move closer to this vulnerable period in the markets.

Looking beyond the immediate future, however, risks seem to abound. Add on an aggressive Fed to keep wage inflation at bay, we just may find the market isn’t ready to tango with such high rates. Currently, the Fed Funds (the overnight bank rate) is 1.5% – 1.75%. If the Fed stays on it’s projected the path of hikes, a year from now the Fed Funds rate will be 2.5% – 2.75%, and a year later 3.5% – 3.75%. When the Fed Funds rate gets to 3%, corporate cash will dry up and be at a level that is consistent with prior recessions.

It is also likely that certain emerging markets will continue to outperform for the 2nd quarter and likely entire year and beyond, compared to US and European equities. This thesis is primarily based on relatively low valuations for emerging markets compared to developed markets, the presence of high valuations in US markets, higher earnings growth rates in emerging markets, a weak US dollar and more favorable demographics in emerging markets compared to the developed world. It is also likely that Japanese equities will outpace US and European equities for the remainder of the year.

Forecasting The Next Recession

Investing in the right asset classes & sectors at the right stage in the business cycle is one of the most important drivers of performance for investors. The same is true by knowing which asset classes and sectors to avoid and when. What’s more, this “timing factor” may indeed have the greatest impact on your financial future. While predicting market downturns and recessions may be a challenge, it is possible to get an early read on forecasting the next recession by analyzing historical data and late-cycle patterns of key economic and market indicators. Current analysis suggests no immediate recession in the next 6 months. However, it is possible that we experience a market-driven sell-off in the next 6 months. Looking out 12 months and beyond, the probability of a recession increases, with an above-average probability occurring in 18 months – 36 months.

In addition to the below charts, I also publish 19 of the most widely-referenced economic charts and market indicators that can be useful in getting an early read on when the next recession may occur. You can be view this at the “Forecasting The Next Recession” page on my website, StrategicStockInvestor.com (click to be re-directed).

In addition to providing the tools and research in order to identify warning sign of an upcoming recession, I also have created a proprietary global ranking and trading system that is comprised of over 150 predictive algorithms. This proprietary system, which has had a very high accuracy rate of predicting winning trades, includes analysis all the major asset classes from US and global equities, fixed-income, real estate and commodities. The rankings are also published at StrategicStockInvestor.com (click to be re-directed).

The Yield Curve is a common predictor of stock market downturns and correctly predicted the downturns in 2000 and 2008. Below are the yields on the 1, 3, 5, 10 and 30-year US bonds, which actually moved sideways and continue to suggest a recession is unlikely in the immediate future.

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Aaa Corporate Bond Relative to 10-Year Treasury Rate

While GDP and the yield curve suggest no recession in site, high-quality corporate debt is just 1% above 10-year treasury rate, providing little room for corporates to tighten from here.

Featured Charts

Gold

Gold continues to maintain its price strength after surpassing its 6-year resistance level but has yet to make a significant upward move.

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Silver

One of the most interesting charts currently in the global markets is Silver. It is at the very end of a multi-year apex. The direction it takes, whether up or down, is likely to become a significant move over many months, possibly years. As previously mentioned, I believe commodities, including silver, will go up from here.